Today we’ll take a closer look at Progress Software Corporation (NASDAQ:PRGS) from a dividend investor’s perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Unfortunately, it’s common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
Some readers mightn’t know much about Progress Software’s 1.5% dividend, as it has only been paying distributions for the last three years. While it may not look like much, if earnings are growing it could become quite interesting. During the year, the company also conducted a buyback equivalent to around 1.0% of its market capitalisation. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Progress Software paid out 107% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Progress Software’s cash payout ratio last year was 22%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It’s good to see that while Progress Software’s dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we’d be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.
Is Progress Software’s Balance Sheet Risky?
As Progress Software’s dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company’s total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Progress Software has net debt of 0.96 times its EBITDA, which is generally an okay level of debt for most companies.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. Net interest cover of 8.14 times its interest expense appears reasonable for Progress Software, although we’re conscious that even high interest cover doesn’t make a company bulletproof.
We update our data on Progress Software every 24 hours, so you can always get our latest analysis of its financial health, here.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well – nasty. The dividend has not fluctuated much, but with a relatively short payment history, we can’t be sure this is sustainable across a full market cycle. During the past three-year period, the first annual payment was US$0.50 in 2017, compared to US$0.66 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.7% a year over that time.
Progress Software has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend’s purchasing power over the long term. Over the past five years, it looks as though Progress Software’s EPS have declined at around 9.5% a year. A modest decline in earnings per share is not great to see, but it doesn’t automatically make a dividend unsustainable. Still, we’d vastly prefer to see EPS growth when researching dividend stocks.
To summarise, shareholders should always check that Progress Software’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We’re not keen on the fact that Progress Software paid out such a high percentage of its income, although its cashflow is in better shape. Earnings per share have been falling, and the company has a relatively short dividend history – shorter than we like, anyway. With this information in mind, we think Progress Software may not be an ideal dividend stock.
Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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